Question

You are evaluating two different silicon wafer milling machines. The Techron I costs $231,000, has a three-year life, and has pretax operating costs of $60,000 per year. The Techron II costs $405,000, has a five-year life, and has pretax operating costs of $33,000 per year. For both milling machines, use straight-line depreciation to zero over the project’s life and assume a salvage value of $37,000. If your tax rate is 35 percent and your discount rate is 9 percent, compute the EAC for both machines. (Negative amounts should be indicated by a minus sign. Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)

Answer 1

Techron I

Time line		0	1	2	3
Cost of new machine		-231000
=Initial Investment outlay		-231000
						100.00%
Sales			0	0	0
Profits	Sales-variable cost		0	0	0
Operating cost			-60000	-60000	-60000
-Depreciation	Cost of equipment/no. of years		-77000	-77000	-77000	0	=Salvage Value
=Pretax cash flows			-137000	-137000	-137000
-taxes	=(Pretax cash flows)*(1-tax)		-89050	-89050	-89050
+Depreciation			77000	77000	77000
=after tax operating cash flow			-12050	-12050	-12050
+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)				24050
+Tax shield on salvage book value	=Salvage value * tax rate				0
=Terminal year after tax cash flows					24050
Total Cash flow for the period		-231000	-12050	-12050	12000
Discount factor=	(1+discount rate)^corresponding period	1	1.09	1.1881	1.295029
Discounted CF=	Cashflow/discount factor	-231000	-11055.0459	-10142.2439	9266.201761
NPV=	Sum of discounted CF=	-242931.09

Year or period		0	1	2	3
EAC			-95971.0828	-95971.0828	-95971.0828
Discount factor=	(1+discount rate)^corresponding period		1.09	1.1881	1.295029
Discounted CF=	Cashflow/discount factor		-88046.865	-80776.9403	-74107.2847
NPV=	-242931.09
EAC is equivalent yearly CF with same NPV =	-95971.08

Techron II

Time line		0	1	2	3	4	5
Cost of new machine		-405000
=Initial Investment outlay		-405000
								100.00%
Sales			0	0	0	0	0
Profits	Sales-variable cost		0	0	0	0	0
Operating cost			-33000	-33000	-33000	-33000	-33000
-Depreciation	Cost of equipment/no. of years		-81000	-81000	-81000	-81000	-81000	0	=Salvage Value
=Pretax cash flows			-114000	-114000	-114000	-114000	-114000
-taxes	=(Pretax cash flows)*(1-tax)		-74100	-74100	-74100	-74100	-74100
+Depreciation			81000	81000	81000	81000	81000
=after tax operating cash flow			6900	6900	6900	6900	6900
+Proceeds from sale of equipment after tax	=selling price* ( 1 -tax rate)						24050
+Tax shield on salvage book value	=Salvage value * tax rate						0
=Terminal year after tax cash flows							24050
Total Cash flow for the period		-405000	6900	6900	6900	6900	30950
Discount factor=	(1+discount rate)^corresponding period	1	1.09	1.1881	1.295029	1.4115816	1.538624
Discounted CF=	Cashflow/discount factor	-405000	6330.275229	5807.591954	5328.066012	4888.134	20115.376
NPV=	Sum of discounted CF=	-362530.56

Year or period		0	1	2	3	4	5
EAC			-93203.8724	-93203.8724	-93203.8724	-93203.87	-93203.87
Discount factor=	(1+discount rate)^corresponding period		1.09	1.1881	1.295029	1.4115816	1.538624
Discounted CF=	Cashflow/discount factor		-85508.1398	-78447.8347	-71970.4905	-66027.97	-60576.12
NPV=	-362530.56
EAC is equivalent yearly CF with same NPV =	-93203.87